- Bond markets appear to be catching up to what equity markets have suspected for a while – that slowing growth, especially in the US and Europe, could eventually be a bigger risk than inflation. For the past three weeks, US government yields have sharply pulled back alongside long-term inflation expectations, while the US 10-year yield fell below the 2-year yield for the third time since April. The moves suggest bond markets, after worrying about surging inflation, are now preparing for a sharp downturn in US growth as the Fed tightens policy further. Meanwhile, US equities have been largely resilient over the past three weeks, after having already suffered a more than 20% drop this year, as investors consider whether a growth slowdown has already been factored into stock prices.
- This diverging backdrop between bonds and equities raises the stakes for the US earnings season starting next week. Will Q2 earnings and corporate guidance for H2 2022 confirm worries about recession risks or will companies be able to reassure investors that the underlying earnings drivers remain healthy? Although US Q2 earnings estimates have been downgraded since April, full-year 2022 US earnings estimates have continued to rise steadily. Hence, equities face further downside risk in the near term if corporate earnings guidance for the rest of 2022 underwhelms.
- According to Refinitiv consensus estimates, Q2 earnings for the S&P500 index rose 5.6% y/y on the back of 10.4% revenue growth. The earnings gains were likely driven by a surge in energy (+223%), industrial (+31%) and material (+19%) sector earnings. However, excluding the energy sector, Q2 earnings are estimated to have declined 2.4%. That would be the first earnings contraction since the pandemic-driven slump in 2020. Such a contraction would mirror macroeconomic data. The Atlanta Fed’s real-time GDPNow forecast for Q2 growth is now signalling a 1.9% annualised contraction. While the forecast has yet to consider most economic data for June, another GDP contraction in Q2, following the 1.6% contraction in Q1, would mean the US entered a technical recession in H1.
- Financial sector earnings will be closely watched to assess the underlying health of the economy. Headline earnings for the sector are estimated to have fallen 20%, but that is primarily because of the write-backs of pandemic loan-loss provisions in the year-ago period. We believe underlying earnings likely rose on the back of higher net interest margins that typically rise with higher interest rates. We will also follow banks’ outlook for loan demand amid a slump in mortgage applications. Consumer credit has risen this year as lower-income households depleted their pandemic-era savings. This trend is likely to extend as long as the job market holds up, which may help offset lower demand for mortgages in the coming quarters.
- A strong jobs data for June would come with its own risks (the consensus estimates 268,000 net new jobs were created). A strong number will likely encourage Fed policymakers to hike the policy rate by another 75bps to 2.5% later this month, especially if US inflation for June (due on 13 July) remains close to May’s 40-year high. Minutes from the Fed’s June policy meeting showed policymakers want to maintain their tightening stance until they see a consistent decline in near-term inflation.
- The mix of a resolutely hawkish Fed policy and downside growth and corporate earnings risks is a key reason why we reduced our exposure to equities in our benchmark asset allocation last month and raised our allocation to bonds. Within bonds, we believe Asia USD bonds offer investors some of the best value, given their overall high quality, relatively low volatility, inexpensive valuations and China’s gradual policy-driven recovery (see our focus on Asia USD bonds on page 7).
- Also on our radar: (i) Biden’s visit to Saudi Arabia and Israel. Will the Saudis agree to boost oil output, or will Biden turn to Iran with a deal? (ii) The G20 meeting in Bali of foreign and finance ministers – with Russia’s Foreign Minister Sergey Lavrov attending; host Indonesia is trying to mediate a resolution to the Ukraine war (iii) China’s new loans and money supply data to confirm if the credit upturn continued into June amid rising infrastructure financing.
by Standard Chartered Weekly Market View
